Investing Basics

Trading and investing are different skills, but they complement each other. Every trader should also be an investor — putting long-term money to work in proven vehicles while using trading for extra returns. This lesson covers the core building blocks.

Stocks (Equities)

A stock represents partial ownership in a company.

How Stocks Make Money

1. Capital appreciation: The stock price goes up, you sell for profit
2. Dividends: The company pays you a share of its profits (usually quarterly)

Key Metrics

• Market Cap: Total value of all shares (share price × shares outstanding)
  • Large-cap: >$10B (AAPL, MSFT, GOOGL)
  • Mid-cap: $2B-$10B
  • Small-cap: <$2B
• P/E Ratio: Price-to-Earnings — how expensive a stock is relative to its profits
• EPS: Earnings Per Share — profit divided by outstanding shares
• Dividend Yield: Annual dividend as a percentage of stock price

Stock Market Indices

• S&P 500: 500 largest US companies — the benchmark
• NASDAQ Composite: Heavily tech-weighted
• Dow Jones Industrial Average (DJIA): 30 large US companies
• Russell 2000: Small-cap companies

Bonds (Fixed Income)

A bond is a loan you give to a government or corporation. They pay you interest, then return your principal at maturity.

Bond Basics

• Face Value (Par): The amount you'll receive back at maturity (usually $1,000)
• Coupon Rate: The annual interest rate paid on the face value
• Maturity Date: When the principal is returned
• Yield: Your actual return based on the price you paid

Types of Bonds

| Type | Issuer | Risk | Typical Yield | |------|--------|------|--------------| | US Treasury | US Government | Very low | 3-5% | | Municipal | State/local govt | Low | 2-4% (tax-free) | | Corporate (IG) | Strong companies | Low-Medium | 4-6% | | Corporate (HY) | Riskier companies | Medium-High | 6-10%+ |

Bond Prices and Interest Rates

This is critical: bond prices move inversely to interest rates.

• When rates rise → existing bond prices fall
• When rates fall → existing bond prices rise

This relationship matters for macro analysis and is covered in depth in the Macro & Fundamentals module.

Exchange-Traded Funds (ETFs)

An ETF is a fund that trades on stock exchanges like a regular stock, but holds a basket of assets (stocks, bonds, commodities, etc.).

Why ETFs Are Powerful

• Diversification: One purchase gives you exposure to dozens or hundreds of assets
• Low fees: Most ETFs charge 0.03-0.20% annually (vs. 1-2% for mutual funds)
• Liquidity: Trade any time during market hours like a stock
• Transparency: Holdings are disclosed daily

Popular ETFs

| ETF | What It Tracks | Expense Ratio | |-----|---------------|---------------| | SPY / VOO | S&P 500 | 0.03-0.09% | | QQQ | NASDAQ 100 | 0.20% | | VTI | Total US Stock Market | 0.03% | | VXUS | International Stocks | 0.07% | | BND | US Bond Market | 0.03% | | GLD | Gold | 0.40% |

Index Funds

An index fund is a type of mutual fund or ETF designed to mirror a specific market index (like the S&P 500).

Why Index Funds Win

Data consistently shows that over 90% of active fund managers underperform their benchmark index over a 15-year period. This is after fees.

Warren Buffett's advice: "A low-cost index fund is the most sensible equity investment for the great majority of investors."

The Simple Portfolio

Many financial experts recommend a simple three-fund portfolio:

1. US Total Stock Market Index (60-80%)
2. International Stock Market Index (10-20%)
3. Bond Index (10-20%)

Adjust the percentages based on your age and risk tolerance (more bonds as you get older).

Diversification

Diversification means spreading your money across different types of investments to reduce risk.

Types of Diversification

• Asset class: Stocks, bonds, real estate, commodities, crypto
• Geographic: US, international developed, emerging markets
• Sector: Technology, healthcare, energy, financials
• Time: Dollar-cost averaging (investing regularly over time)

The Free Lunch

Diversification is often called the only "free lunch" in investing. By holding uncorrelated assets, you can reduce your portfolio's risk without necessarily reducing your expected return.

However, diversification does NOT protect against all losses — in a market crash, most assets can fall together.

Trading vs. Investing

| | Trading | Investing | |---|---------|-----------| | Time Horizon | Minutes to months | Years to decades | | Goal | Short-term profit | Long-term wealth building | | Effort | Active, time-intensive | Passive, set-and-forget | | Risk | Higher (per trade) | Lower (over time) | | Tax Treatment | Short-term capital gains | Long-term capital gains (lower rate) |

The Smart Approach

Many successful traders use a split strategy:

• 80-90% of capital: Long-term investments (index funds, retirement accounts)
• 10-20% of capital: Active trading account

This way, even if your trading doesn't work out, your wealth still grows through investing.

Key Takeaways

• Stocks represent company ownership; bonds are loans to entities
• ETFs and index funds provide instant diversification at low cost
• Over 90% of active managers underperform index funds over 15 years
• Diversification reduces risk — spread across asset classes, geographies, and time
• Smart traders also invest: 80-90% in long-term investments, 10-20% in trading